Iger’s Sports Contracts Squeeze Profit as Disney Shares Stall

ESPN, the cable television network that has driven profit growth at Walt Disney Co. much of this decade, may produce smaller gains in coming years, crimping the stock price of the second-largest media company.

Professional football, baseball, basketball and auto racing contracts that take effect by October 2009 will boost expenses by $1.02 billion a year, just as agreements with cable operators Comcast Corp. and Time Warner Cable Inc. limit subscriber-fee increases to an annual average of 7 percent, estimates UBS Securities analyst Michael Morris in New York.

The cable unit, source of 46 percent of Disney's operating earnings last year, will see profit growth slow by 4 percentage points in fiscal 2008 from the year ending this month, Morris estimates. That will lop off $160 million at a time when broadcasting and theme parks at Burbank, California-based Disney also generate smaller increases, and film studio earnings drop 19 percent, he estimates.

“Disney is entering a period of slower growth,'' Morris, who rates the shares “neutral'' and doesn't own any, said in an interview. “ESPN is at the center of that equation.''

Ten of Disney's 12 biggest institutional shareholders have reduced their stakes, filings from June show.

Disney shares are little changed this year, following a 42 percent rise in Robert Iger's first 15 months as chief executive officer. They fell 5 cents to $33.99 at 10:05 a.m. in New York Stock Exchange composite trading, and before today were 6.2 percent below a six-year high of $36.30 set May 23.

Boosting Revenue

“The only way the company can continue to crank is if they continue to basically have a lock on the sports market at ESPN,'' said Richard Steinberg, whose Steinberg Global Asset Management in Boca Raton, Florida, sold more than half the 36,000 shares it held at the start of this year. He forecasts the stock won't surpass $36 for the next year.

Iger, 56, is betting ESPN can boost revenue by expanding advertising online and on channels such as ESPN2, and by selling premium Internet services. New sports contracts include rights to beam games to digital devices such as cell phones. Iger declined to comment.

“We are getting tremendous value for these investments,'' George Bodenheimer, president of ESPN and co-chairman of Disney Media Networks, said in an interview. “Our ability to maximize these agreements has never been greater.''

ESPN Impact

ESPN, the most-watched sports network, makes up about 70 percent of Disney's cable-unit operating income, Morris estimates. Profit at the unit, including Disney Channel and ABC Family, will climb 15 percent to $4.08 billion next year, following this year's 19 percent rise, he estimates.

Networks run by the National Football League, Major League Baseball, the National Basketball Association and News Corp.'s Big Ten give ESPN more competition. Comcast, in Philadelphia, Time Warner Cable in New York and satellite provider DirecTV Group Inc. in El Segundo, California, have added sports programs.

ESPN collects as much as $3.25 per subscriber in monthly affiliate fees, the highest in cable, compared with about $2 for News Corp.'s Fox Sports, said researcher Paul Kagan in Carmel, California. The fees make up roughly two-thirds of ESPN's revenue, and rose 10 percent to 20 percent annually before the recent contracts, he estimates.

Digital Growth

Disney's investments in the Internet and in video games won't pay off fast enough to make up for cable and film, Morris said.

Net income may increase 2.9 percent to $4.23 billion in 2008 from a projected $4.11 billion excluding a gain from asset sales this year, Banc of America Securities analyst Jonathan Jacoby wrote in an Aug. 2 research note. He is based in New York and rates the shares “neutral.''

“Iger's mettle increasingly will be tested in the years ahead,'' said Standard & Poor's analyst Tuna Amobi in New York, who has a “strong buy'' rating and praises the CEO for buying Pixar and adapting to distribution changes.

Disney repurchased $5.2 billion of its stock in the first nine months this year. An additional $2.5 billion in buybacks through 2008 will boost earnings by 8 cents a share, Morris estimates.

The company agreed to pay $1.1 billion a year for eight years of Monday night NFL games on ESPN starting last season, up from $550 million a year on Disney's ABC, which had the rotating Super Bowl. ESPN is 20 percent owned by Hearst Corp.

Annual outlays of $293.5 million for baseball, up from $141.8 million, and $270 million starting this season for NASCAR are raising programming costs, Morris said. Both deals cover eight years. Pro hockey, baseball playoffs, PGA golf and Sunday NFL games that cost $600 million a year have been dropped.

An eight-year NBA agreement in June will increase ESPN's cost to carry games by $97 million annually to $496.9 million beginning in October 2008, Morris estimates.

On an Aug. 1 conference call, Iger was asked about the potential for increasing profit margins at Disney units.

“It will be hard to grow their margins over the long term, even though ESPN will continue to deliver significant growth for the company,'' Iger said. “They are coming off, as you know, a relatively high base.''

To contact the reporter on this story: Andy Fixmer in Los Angeles atafixmer@bloomberg.net